Steve Hamilton is a Tampa native and a graduate of the University of South Florida and the University of Missouri. He now lives in northern Kentucky. A career CPA, Steve has extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.

Monday, March 7, 2016

Getting ROBbed

I was
skimming a Tax Court decision that leads with:

“… respondent issued a notice of deficiency … of $249,263.62,
additions to tax … of $20,228.76 and $22,476.41, respectively and an enhanced
accuracy-related penalty … of $63,918.33”

It was Roth
IRA decision.

We have spoken
before about putting a business in an IRA, and a Roth is just a type of IRA.
This tax structure is sometimes referred to as a “ROBS” – roll-over as business
start-up.

Odds are the
only one who is going to get robbed is you. I had earlier looked into and decided
that I did not like the ROBS structure. There are too many ways that it can
detonate. I do not practice high-wire tax.

I have also noticed
the IRS pursuing this area more aggressively. There often is complacency when a
“new” tax idea takes, as the IRS may not respond immediately. That lag is not
an imprimatur by the IRS, although self-interested parties may present it as
such. I have been in practice long enough to have heard that sales pitch more
than once.

Let’s
discuss Polowniak v Commissioner.

Polowniak had
over 35 years of marketing experience with Fortune 500 companies, including
Proctor & Gamble, Johnson & Johnson and Kimberly Services. In 1997 he
formed his own company – Solution Strategies, Inc. (Strategies). He was the
sole shareholder and its only consultant.

In 2001 he
received a nice contract - $680,000 – from Delphi Automotive Systems – which
had him travel extensively to Europe, Asia and South America.

Now the
turn. His financial advisor recommended an attorney who pitched the idea of
“privately owned Roth IRA corporations,” also known as PIRACs. These things are
not rocket science. In most cases an individual already has an existing company,
likely profitable or soon to be. Said individual sets up a Roth IRA. Said Roth
purchases the stock of a new corporation (NewCo), which amazingly does exactly
the same thing that the existing corporation did, and likely with the same
customers, vendors, employee, office space and so on.

The idea of
course is that NewCo is going to be very profitable, which allows the
opportunity to stuff a lot of money into the Roth in a very short period of
time.

So Polowniak
sets up a NewCo, which he names Bevco Investments, Inc. (Bevco). There is a
little flutter in the story as Bevco selects a January year-end, meaning that a
sharp tax advisor may have the opportunity to move things back-and-forth
between a calendar-year taxpayer and an entity that doesn’t file its tax return
until a year later.

Strategies
and Bevco entered into an agreement whereby it would receive 75% of Strategies
revenues for 2002.

By the way,
Delphi was never informed of Bevco. Neither was the administrative assistant.

The years
passed. Polowniak let the subcontract with Bevco lapse.

And he
started depositing all the Strategies revenue from Delphi into Bevco. There was
no more pretense of 75 percent.

Bevco was
finally dissolved in 2006.

And then
came the IRS.

It went
after Solutions, which did not report the $680,000 from Delhi. You remember,
the same amount it was to share 75% with Bevco.

Sheesh.

It also came
after Polowniak personally. The IRS wanted penalties for excess funding into a
Roth.

Huh?

There are
limits for funding a Roth. For example, the 2015 limit for someone
age-50-and-over (ahem) is $6,500. If you go over, then there is a 6% penalty.
Mind you, the 6% doesn’t sound like much, but it becomes pernicious, as it compounds
on itself every year. Tax practitioners refer to this as “cascading,” and the
math can be surprising.

How did he
overfund?

Simple. He
took existing money from Solutions and put it into Bevco. It is the equivalent
of you depositing money at Key Bank rather than Fifth Third.

Polowniak’s
job right now was to convince the Court that was a substantive reason for the Solutions
–Bevco structure. If Bevco was just an alter ego, he was going to lose and lose
big.

He trotted put Hellweg, a tax case featuring Roth IRAs and Domestic International
Sales Corporations (DISCs). Whereas the taxpayer won that case, there was some
arcane tax reasoning behind it, likely exacerbated by those DISCs.

The Court
did not think Hellweg was on point.
It thought that Repetto was much more
applicable, pointing out:

·All
the services performed by Bevco had previously been performed by Polowniak
through Strategies

·Polowniak
performed all the services under the contract with Delphi

·Since
he was the only person performing services, the transfer of payments between
Strategies and Bevco had no substantive effect on the Delphi contract

·Delphi
did not know of the contract with Bevco; in fact, neither did the
administrative assistant

·The
business dealing between Strategies and Bevco were not business-normative. For
example, Bevco never kept time or accounting records of its services, nor did
it ever invoice Strategies.

The Court
decided against Polowniak. It did not respect the PIRAC, and as far as it was
concerned all the Delphi money put into Bevco was an overfunding.

And that is
how you blow through a third of a million dollars.

Is there
something Polowniak could have done?

He could of
course have respected business norms and treated both as separate companies with their own accounting systems, phone numbers, contracts and so forth. It
would have helped had Strategies not been depositing and withdrawing monies
from Bevco’s bank account.

Still, I do
not think that would have been enough.

There are
two major problems that I see:

(1)There was an existing contract in
place with Delphi. This is not the same as starting Bevco and pounding the
streets for work. There is a very strong assignment of income feel, and I
suspect just about any Court would have been disquieted by it.

(2)There were not enough players on the
field. If I own a company with 75 employees, I may be able to take a slice of
its various activities and place it inside a PIRAC or ROBS or whatever, without
the thing being seen as my alter ego. Polowniak however was a one-man show. This
made it much easier for the IRS to argue substance over form, which the IRS
successfully argued here.

My advice?
Leave these things alone. There are a hundred ways that these IRA-owned
companies can blow up, and the IRS has sounded the trumpet that it is pursuing
them.

About Me

Thirty years years in tax practice. It's a long time, and I have seen virtually everything short of the fabled tax-exempt unicorn. I was raised in Tampa, went to school in Missouri, taught at Eastern Kentucky University, lived in Georgia, got pulled to Cincinnati when I married, have in-laws in England and a daughter going to the University of Tennessee. I am not sure where I will wind up next, but I hope there is better weather.